Stock Market Crisis, 2008
The US housing market bubble has produced the present US financial crisis, affecting especially the stock market. This time, the crisis is believed to be the worst ever from other such crisis occurred since the World War II era. According to the financial experts, this crisis now marks an “end of an era of credit expansion based on the dollar as the international reserve currency”, which has lasted for over 60 years now.
The other financial crisis comprised of the nature of boom-bust processes. The boom-bust process usually center around credit and involves a misconception. This time, the easy credit generated demand that pushed up the value of the property beyond reasonable levels. People, armed with easy credit facilities, bought houses expecting that they could refinance their mortgage at a profit. This misconception, in turn, started a bubble.
The financial authorities stepped in every time the credit expansion ran into trouble. They threw in liquidity and attempted to stimulate the economy by expecting general public to believe that the financial problem has been solved effectively!
Also, globalization during the past decade allowed the United States to consume more than it produced by importing more goods. Thus, the US current account deficit reached a whooping 6.2 per cent of gross national product (GNP) in the year 2006. During the entire duration since globalization, the US financial institutions encouraged the US consumers to buy beyond their means through easier borrowings on generous terms. The regulations on financial aspects became nonexistent in recent years. Thus, a super-boom was created, leading to today’s financial crisis. The stock market is showing every sign of an economic slowdown and a looming recession.
The super-boom went out of control leading to a crisis, because the financial authorities were unable to calculate the risks and more-or-less, relied on the banks’ risk management methods. Many other factors plunged the US economy and the stock markets into deeper troubles.
The crisis began with the subprime mortgages and spread to collateralized debt obligations, this in turn endangered municipal and mortgage insurance and reinsurance companies, and threatened to unravel the multi-trillion-dollar credit market.
Investment banks’ commitments to leveraged buyouts became liabilities. Market-neutral hedge funds turned out not to be market-neutral and had to be unwound. The terminal blow came when interbank lending, which is the heart of the financial system, was disrupted. The central banks had to put in an unexampled amount of money and extend credit. That made the crisis graver than any since the World War II.
The power of the financial authorities to energize the economy is constrained by the unwillingness of the rest of the world to amass additional dollar reserves. Until recently, investors were trusting that the US Federal Reserve would do whatsoever it needs to do to avoid a recession, since that is what it exercised on past occasions. Now they’ll have to realize that the Fed may no more is in a position to do so. With oil, food and other commodities, the Fed also is concerned of inflation.
It seems that the pivotal role played by the United States stock markets for over 5 decades is being severely challenged by some of the growing Asian economies, especially China, and will take many years for the United States to get back on top.